Changes in Store for FHA-Backed Loans, Says Commissioner

The FHA has backed more than half of first-time mortgages. The Federal Housing Administration has become a lifeline for the flagging housing market. Nearly half of all first-time buyers looked to the agency for home loans in the second quarter of last year. With that kind of demand, is the FHA becoming a risk for the U.S. taxpayers who back it? And what's the best way to address potential pitfalls without derailing the budding housing recovery?

That was the topic of a March 11 hearing by the House Subcommittee on Housing and Community Opportunity as it deliberated on the FHA Reform Act of 2010. At the hearing, FHA Commissioner David Stevens described plans to develop stricter rules for lenders and change rules for borrowers, so the riskiest borrowers have more skin in the game. The changes will have a major impact on the ability of borrowers top get mortgage loans.
At the hearing, Commissioner Stevens laid out the situation faced by the FHA. Its reserves have dropped to $3.6 billion, or about 0.5 percent of the $685 billion in loans the FHA has insured -- significantly less than the 2 percent of outstanding loans that the law requires it hold in reserve. But the agency can borrow from the U.S. Treasury without limit and without Congressional approval, so it can essentially become a black hole for taxpayers.

Stevens characterized the FHA's current expanded role in the mortgage marketplace as "temporary," but key to building a "bridge to economic recovery" and "helping to ensure that mortgage financing remains available until private capital returns."

Rebutting critics who say that the FHA has become the next subprime lender, Stevens vehemently defended its lending practices. "Subprime delinquencies are 240 percent higher than the FHA's for a reason -- subprime loans had much weaker underwriting standards than the FHA," he said.

So how will these changes impact your ability to get an FHA loan?

The FHA needs to act quickly to rebuild its capital reserves, so it's increasing its upfront premium temporarily to 225 basis points starting April 5. The FHA got the authority to raise this premium to as high as 300 basis points in the Housing and Economic Recover Act of 2008. But the FHA hopes that dramatic increase won't be required for long. It's asking Congress to offset the higher upfront premium with an annual premium increase -- to 85 basis points for loans up to 95 percent loan-to-value, and 90 basis points for LTVs above 85 percent, which is closer to mortgage insurance premiums in the traditional mortgage marketplace. If the FHA does get Congressional approval for this increase, the upfront premium will drop down to 100 basis points.

The FHA also proposes a floor on credit scores to qualify for a 3.5 percent down payment. You'll need a FICO score of 580 or above if you want to get an FHA loan with just a 3.5 percent down payment. If you have a score between 500 and 579 you can get an FHA loan, but you'll need to put 10 percent down. If your score is below 500, well, forget about an FHA-insured loan. These new guidelines are based on an analysis of existing loans, Stevens explained. "Loans below the guidelines demonstrate a seriously delinquent rate of 31.1 percent, while loans above the guidelines currently demonstrate a seriously delinquent rate of 7.6 percent," he said.

Some critics think the FHA should raise its minimum down payment to 5 percent, but Stevens said in his testimony that "such a policy change would reduce the volume of loans endorsed by the FHA by more than 40 percent, while only contributing $500 million in additional budget receipts. This translates to more than 300,000 fewer first-time homebuyers and would have significant negative impacts on the broader housing market. . ."

The FHA also proposed that the maximum permissible seller concession be reduced to 3 percent from its current 6 percent, which is more in line with industry norms. Stevens says this higher percentage "exposes the FHA to excess risk by creating incentives to inflate appraised value.

John A. Courson, President and Chief Executive Officer of the Mortgage Bankers Association, raised some concerns about reducing seller concessions because he said they could "have an adverse effect on the population that traditionally has sought FHA's assistance to purchase a home." He went on to say, "the reduction in seller concessions will primarily impact low-to-moderate, first-time and minority homebuyers."

Lenders will face greater scrutiny, too

The FHA wants to hold all lenders to the same standard and permit the FHA to "recoup losses through required indemnification for loans that were improperly originated and the error may have impacted the original loan decision, or in which fraud or misrepresentation were involved," Stevens testified. The FHA currently has this authority for loans approved through the Lender Insured process, which accounts for 70 percent of FHA loans. They want this authority extended to Direct Endorsement lenders, who currently undergo a pre-endorsement review by the FHA prior to the issuance of the insurance certificate.

Courson testified, "by extending this additional responsibility onto DE lenders, FHA will cause responsible lenders to become even more cautious underwriting loans. FHA's action would run counter to its mission by reducing the availability of affordable housing credit."

More visibility needed

Andrew Caplin, Professor of Economics at New York University, argued that the "FHA should expand access to its books in the spirit of transparency." He expressed concern that the FHA is not adequately assessing its risk to the taxpayers. He testified that the FHA appears to have ignored "information about future claims" that are "contained in current delinquency rates." Caplin also questioned whether the impact of high unemployment is "adequately captured."

Caplin wants the FHA to "amend its risk assessment methodology" to work on these and other problems outside researchers have identified. He said the "best way to keep the FHA risk analysis at the frontier is to open up access to the data to outside researchers." Given that taxpayer money is at risk, that sounds like a great first step to protecting all of us from what could potentially be a black hole.

Lita Epstein has written more than 25 books including "Reading Financial Reports for Dummies."
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